Should You Steer Clear of Market Highs?

by Jeff DeMaso | March 18, 2014 1:00 pm

Should You Steer Clear of Market Highs?

With U.S. stocks near all-time market highs (of Vanguard’s 42 diversified domestic equity funds, most are within 2% of their all-time highs) some investors are asking if they should wait for a pullback before putting money in the markets. Nobody wants to invest at a market high only to start losing money from the get-go. But should the fear of a potential loss keep us on the sidelines?

No!

In fact, even if you were “lucky” enough to have invested at the market highs in each of the last 30 years, your end result was still satisfactory as long as you held the course.

Let’s compare two investors: Disciplined Dave and Hapless Harry.

Both Dave and Harry invest $1,000 in Vanguard 500 Index Fund (VFINX[1]) at the end of 1983. They both invest an additional $1,000 in the fund each and every year for the next 30 years. Disciplined Dave simply adds his money on the last trading day of every year. Hapless Harry tries to pick his spots, but he easily lays claim to having the worst timing in modern Wall Street history, and ends up adding his $1,000 at the fund’s highest price each calendar year.

It’s pretty obvious that Disciplined Dave should have a lot more money at the end of 30 years than Hapless Harry, right? Well, Dave compounded his money at a 9.9% annual rate, turning his $31,000 into $177,176 at the end of 2013 (including his final contribution at the end of that year).

Harry, despite his unfortunate timing, compounded his money at a 9.5% rate, and ended up with $169,153 (also including his final contribution, coincidentally made at the market’s high on the last day of the year). As a frame of reference, the S&P 500 Index itself compounded at a 10.9% rate over this 30 year period.

For all his bad luck (his timing could not have been any worse) Hapless Harry ended up with only $8,023 less than Disciplined Dave.

2014 03 07 longterm Should You Steer Clear of Market Highs?

What can we learn from Hapless Harry? Despite his poor timing, Hapless Harry did have a few things going for him. Harry stuck to a regular investment plan. Even though every trade he made immediately lost money, Harry, like Dave, was disciplined and invested $1,000 every year. Harry also never panicked—he did not sell a single share. Finally, Harry had a long time-horizon.

The lesson is that timing isn’t everything. Spending time in the market—which means being disciplined, consistent and staying focused on the long run—goes a long way towards making up for unlucky timing. And in reality, your luck can’t be as bad as Hapless Harry’s.

Yes, we may be at a market high. But we won’t know that until after the fact, and what might be a market top could just as easily be a pause before a rally to higher highs. If you are on the sidelines, take a lesson from Hapless Harry, and make a plan to get in the game—as a long-term investor.

Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors[2], a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.

Endnotes:
  1. VFINX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VFINX
  2. The Independent Adviser for Vanguard Investors: http://investorplace.com/order/?sid=WRC137

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